Massive numbers of cars, pickups, SUVs, and vans are on the move! In 2012 in the United States, approximately 233 million registered light-duty vehicles1 traveled about 2.7 trillion miles on U.S. highways.2 And each licensed driver drove an estimated 12,579 miles annually3 To travel these miles, consumers purchased approximately 124 billion gallons of fuel.4
Drive down any U.S. highway and you will see a seemingly endless number of gas signs. They’re everywhere—colorful, big, bright, carefully designed, and strategically placed signs to grab attention. On July 7, 2008, the retail price for regular grade gasoline in the United States reached an all-time average high of $4.11 per gallon.5 But even at lower prices, most consumers still check out gas signs to find the best price. After all, every dollar saved at the gas pump is a dollar that can be spent on other things.
In recent years, the amount U.S. households have spent on gasoline has averaged approximately 5 percent of total household expenditures.6 In 2011, the average U.S. household spent $2,655 on gasoline, and in 2012 that amount increased to $2,912.7 In 2013, however, the amount dropped below the 2011 level—to $2,600.8 In 2014, the average U.S. retail price of a gallon of regular gasoline peaked in June at $3.709; for the remainder of the year, gas signs changed mainly in one direction—down. That downward trend has continued into 2015, and the average U.S. household is expected to spend even less on gasoline in 2015 than in 2014. Gasoline expenditures are on track to fall to their lowest level in 11 years and dip below $2,000 for the first time since 2009.10
What factors drive gasoline prices? How is the price of gasoline determined? In other words, what’s behind the signs? Answers to these questions can be found by examining factors that influence gas prices.
The price of every gallon of gasoline includes taxes—federal, state, and local taxes.11 The federal excise tax on gasoline has remained at 18.4 cents per gallon since 1993, with about 60 percent of the amount set aside for highway and bridge construction.12 State gasoline taxes vary, however, and the average state tax on gasoline is 24.17 cents per gallon. Some states and localities add additional taxes to the price of gasoline, including local and state sales taxes and a variety of other taxes.13
|SELECTED STATE GASOLINE TAXES|
|State||Tax cents per gal.||State||Tax cents per gal.|
In the United States, seasons of the year affect gasoline prices. Generally, prices begin an upward trend in the spring. U.S. refineries often conduct maintenance at this time of year, which can lead to a drop in gasoline production and thus a decrease in supply.14 Also, in warmer temperatures, government regulations require different gasoline formulas, which are better for the environment. The additives required for the summer formula increase the production costs for refineries and thus the prices paid at the pump. Warmer temperatures also bring increased travel, which increases the demand for gasoline, and this translates into higher prices at the pump. Colder temperatures, on the other hand, can lead to savings at the pump: People tend to travel less (reducing demand), and the winter formula used in some areas is less costly to produce.15
Unplanned events such as severe weather and other natural disasters can affect gasoline prices. Even the anticipation of a potentially destructive event can trigger increased demand and, in turn, increase prices. If events shut down refineries or disrupt the supply of gasoline, the reduced supply will tend to cause prices to rise. As the following report shows, Hurricane Katrina, which struck the Gulf Coast in 2005, is one (of many) hurricanes that caused a severe reduction in supply: According to the Minerals Management Services (MMS), as of 11:30 Central Time August 31, 2005, Gulf of Mexico oil production was reduced by over 1.371 mb/d [millions of barrels per day] as a result of Hurricane Katrina, equivalent to about 91.45 percent of daily Gulf of Mexico oil production (which is 1.5 mb/d).16
As mentioned earlier, taxes added at the local level cause gasoline prices to vary. Other location-specific factors can make prices differ as well. For example, ordinary business expenses, such as wages, rent, insurance, and utilities, can vary widely.17 Also, the number of competitors plays a role in gas pricing. For example, gas stations physically close together must aggressively compete on price to gain customers, whereas gas stations farther apart have more flexibility in pricing. Generally, fewer gas stations mean higher prices. And traffic patterns can affect gasoline prices as well. Stations located in highly traveled areas with easy access naturally have more customers.
Two additional factors that may affect gasoline prices include population density and the availability of public transportation. Population density determines the number of potential gasoline customers—that is, the potential demand for gasoline. Public transportation also can affect the demand for gasoline: The more people choose public transportation over driving, the fewer gallons of gasoline are sold.18
The process of creating gasoline from beginning to end—from oil well to gas station—requires transportation, which affects pricing. Most gasoline is shipped from refineries (where crude oil is refined into gas) by pipeline to storage facilities near sales regions. From there, trucks deliver the gasoline to stations. Usually, gasoline prices tend to be higher the farther the gasoline must travel to get to the pump. Once again, location can affect prices at the pump. Ownership of the refineries and stations can affect transportation prices as well. If the final point of sale (a gas station) is owned and operated by the refiner, the transportation costs, and ultimately the cost of the gasoline, will tend to be lower.19
According to the U.S. Energy Information Administration (EIA), changes in the price of crude oil have been the primary reason for changes in U.S. gasoline prices in recent years.20 The EIA estimates that as much as two-thirds of the price of gasoline is due to crude oil and refinery costs.21 Crude oil is sold by the barrel. If nothing else changes, a $1 change in the price of a barrel of crude oil will result in approximately a 2.4-cent change in the price of a gallon of gasoline.22
Because the price of crude oil is the primary driver of gasoline prices, trends in crude oil prices are related to trends in gasoline prices. To understand crude oil pricing, some basic information is helpful. The prices of two particular crude oils, West Texas Intermediate (WTI) and Brent, serve as benchmarks for the pricing of other crude oils. That is, buyers and sellers look at the prices of these two crude oils to determine prices of other crude oil. WTI and Brent are basically the same product with only slight differences. WTI, often called Texas sweet light crude, is both extracted and refined in the United States. Its price serves as a benchmark for prices of some crude oil in the United States. Cushing, Oklahoma, a major trading hub for U.S. crude oils, is the headquarters for setting the price of WTI. Brent is sourced from European oil fields in the North Sea and refined in Europe. In recent years, Brent crude oil has become the primary international benchmark for pricing crude oil.23
Overall, the prices of WTI and Brent tend to move in the same direction and gasoline prices tend to follow the ups and downs in the prices of these crudes.
The price of crude oil is determined by global supply and demand. As global demand increases or supply decreases, the price of crude oil increases. Conversely, as global demand decreases or supply increases, the price decreases.
Global crude oil demand is the total crude oil demanded from all countries in the world. Some countries demand far more than others, and the demand from each country can fluctuate. Some countries, however, are currently on upward or downward trends.
The demand for crude oil in the United States is affected to a large degree by driving since approximately 45 percent of the total amount of crude oil consumed in the United States is for gasoline to fuel private passenger vehicles.24 And despite an increase in population, there has been a decrease in the demand for fuel used for consumer driving in recent years. A 2014 study by the University of Michigan Transportation Research Institute attributes this decreased demand to several factors, including increased vehicle fuel economy, increased telecommuting, increased use of public transportation, and a trend toward urbanization.25 In addition, the study revealed the following U.S. trends:
This decrease in the demand for crude oil has also occurred in Europe. For Russia specifically, a downturn in the economy is expected to result in a decrease in their demand for crude oil in both 2015 and 2016.26 But some countries in Asia, Latin America, and the Middle East, for example, are increasing their fuel consumption.27 In China, the world’s second-largest oil consumer (behind the United States), demand for crude oil is expected to continue an upward trend. One driving force behind this trend is sales of private passenger vehicles, which have increased 29 percent over the past 13 years.28
In 2014, the cumulative global demand for crude oil was approximately 91.4 million barrels per day. According to the EIA, global demand is expected to increase by 1 million barrels per day in both 2015 and 2016.29 Although U.S. demand for crude oil has decreased, global demand is expected to reach 93.4 million barrels per day by the end of 2016.
As global demand for crude oil has increased, the EIA estimates that global inventories have increased as well, by almost 0.8 million barrels per day in 2014. This stockpiling is expected to continue throughout the first half of 2015.30 The supply of crude oil available worldwide is largely controlled by the Organization of the Petroleum Exporting Countries (OPEC). OPEC is a group of 12 countries that attempts to actively manage how much oil is produced by setting production targets for its members. (The technical term for this type of organization is cartel.) OPEC countries produce approximately 40 percent of the world’s crude oil and about 60 percent of total crude oil traded internationally. Because this share controlled by OPEC is so large and widespread, its actions greatly affect global supply and, ultimately, gas prices.31
The global supply of crude is also affected by U.S. crude production. In 2015, U.S. production is expected to average 9.3 million barrels per day, which is an increase of 700,000 barrels per day above the 2014 level.32 Every barrel of crude oil produced in the United States contributes to the total global supply.
In addition, oil reserves are an important consideration. Oil reserves, or proved reserves, are amounts of crude oil in a given area known to be recoverable with reasonably certainty in the future—but not pumped yet. U.S. crude oil reserves rose for the fifth consecutive year in 2013, increasing by 9 percent over the 2012 level to 36.5 billion barrels. The increase in U.S. reserves serves as an indicator of potential future crude production. Specifically, Texas remains the leading state in total oil reserves, increasing from 11.1 billion barrels in 2012 to 12 billion barrels in 2013. However, among individual states, in 2013, North Dakota had the largest increase in oil reserves: 51 percent, for a total of 1.9 billion barrels.33
Oil prices in the United States respond to both the international and domestic supplies of crude oil. In recent times, the surge in North American crude oil output combined with the production in OPEC countries has created a global supply that exceeds global demand.34 In turn, crude oil prices—and thus gasoline prices—have spiraled downward.
According to the Federal Highway Administration, there are over 164,000 miles of highways in the United States.35 Along these miles and miles of highways are gas signs that prominently display current prices. Behind the signs are numerous factors that determine gasoline prices: taxes, location, seasonal and weather effects, but especially the price of crude oil. The global supply and demand for crude oil dictate its price in the global marketplace and ultimately the price at the pump.
Crude oil prices are historically volatile, and statistics for the supply and demand of crude oil are a snapshot of a moment in time. The industry continues to change and, with all factors considered, what’s happening today can—and will—change tomorrow. We can expect gasoline prices to change in response. Of course, so will the numbers on the signs.